Stoking up housing boom wrong path for UK

More supportive fiscal policy would have meant earlier, more balanced recovery

by Trevor Greetham

Thu 29 Aug 2013

With the 2015 general election coming gradually into view, the UK government has lost patience with asking the British people to live within their means. Instead it has unleashed the beast that did the damage in the first place by tempting consumers to leverage their balance sheets into a new housing bubble.

Many will seize on the UK economic recovery now gradually under way as evidence austerity worked. In fact, the reverse is true. Stronger growth will surely see the budget deficit shrink as it has already in the US, but a more supportive fiscal stance during the recession could have delivered an earlier and more balanced recovery. Byegones are not byegones. The stagnation of the last few years will have a long-lasting impact on potential growth. A further sharp increase in consumer debt is hardly a good price to pay to reduce government borrowing.

It is five years since the failure of Lehman Brothers plunged the world into depression. Different countries responded in different ways. America’s decision to keep fiscal policy as loose as possible has allowed its economy to recover. Measures of US economic activity exceeded their 2008 levels two years ago, the budget deficit is down by a half and the recovery has been steady enough for the Federal Reserve to talk credibly about the need to raise interest rates at some point.

The UK, in common with most European countries, opted to focus on the high level of government debt in the aftermath of the financial crisis. The authorities raised taxes and cut spending into the recession. Front-loaded austerity failed to trigger the spontaneous private sector recovery the hard-line advocates of such policies expected. All the countries following this path have seen output remain substantially below pre-crisis levels.

The lack of growth in the austerity nations should have come as no surprise, with monetary policy transmission channels clogged and the global nature of the slowdown keeping exports weak. In a balance sheet recession, banks want to shrink their loan books and consumers want to pay down debt. The role of government at these times is to support economic activity until excess consumer debt has been worked off and a sustained recovery has taken hold – even if this means a higher public debt burden in the meantime.

In stoking up a housing boom UK policy makers are doing the exact opposite, tempting a new generation of consumers into debt in the hope the government can improve its own financial position. The Bank of England’s forward guidance framework is designed to keep mortgage rates low for years. An expanding range of government schemes is adding fuel to the fire by underwriting house prices or mortgage debt directly using tax payers' money.

Growth of any kind is clearly good news for public finances as tax revenues surge and the cost of unemployment benefits drops. However, a policy leaning so heavily on the monetary side builds up the risk of another house price crash further down the line once spare capacity has been used up and interest rates rise to head off inflation.

We will never know what might have happened had policy settings been different. What seems certain is a more supportive fiscal policy would have brought an earlier and less unbalanced recovery. A rise in Value Added Tax would not have slashed real disposable income early in the recession. Major infrastructure programmes could have boosted the supply side of the economy while creating employment and demand.

As things stand, the lateness of the UK’s recovery comes at a cost. The long-term unemployed have lost valuable skills, economic stagnation has seen an unnecessary further rise in government debt and the consumer is coming out of the recession with more debt than it had going into it. You can’t help thinking that is storing up trouble for the future.

Trevor Greetham, Member of the OMFIF Advisory Board, is Asset Allocation Director and Portfolio Manager at Fidelity Investments International.